Trading Plan
Purpose:
The purpose of this document is to record the methodology to be used by The Money Tree for successfully trading covered calls and naked puts.
Objective:
The primary objective in following this plan is to achieve an annual ROIC of 15% thereby allowing me to double my money every 5 years. A secondary objective will be to have a minimum of 90% of all trades be closed at a profit.
Covered Call “Show The Trade” Selection Strategy:
In general terms the strategy used will mirror that developed by Ron Groenke as described in his book, Show Me the Money. Ron’s Vision V software will be used to identify equities meeting the criteria listed below.
(1) Annual sales/revenue > $1 billion
(2) Market Capitalization > $1 billion
(3) Positive Year over Year Revenue Growth
(4) Positive Earnings in at least 3 of last 4 quarters
(5) Average daily trading volume > 500,000 shares
(6) Positive Bare Cash
Equities will be ranked based on these criteria and the following fundamental, technical, and Vision V proprietary parameters:
Fundamentals
(1) Price / Book
(2) Net Profit Margin
(3) Price / Earnings
(4) Projected Price / Earnings
(5) Return on Assets
(6) Return on Equity
(7) Cash per Share
(8) Debt / Equity
(9) Operating Cash Flow
(10) Leveraged Cash Flow
Technicals
(1) Current Price relative to 20/50/200 Day Moving Averages
(2) Trend of 20/50/200 Day Moving Averages (moving up/down/flat)
(3) Position of 20/50/200 Day Moving Averages relative to each other (crossovers)
Vision V Proprietary Parameters
(1) Buy Rank (between +5 and +10 preferred)
(2) TAI (between -5 and +10 preferred)
(3) Gold $ Score > 80
(4) Buy Limit > Current Price
CC positions on selected equities will be established based on the following criteria:
(1) No new CC positions will exceed 10% of total capital available in CC portion of portfolio
Entering Positions:
(1) New CC positions will always be entered using a buy/write trade. Troy will never “leg into a position.”
(2) New CC positions can be entered at any time provided they meet the prorated minimum ROIC criteria (see above).
(3) However, new CC positions will generally be entered in the week following expiration Friday.
(4) The order of preference in selecting CC options will be one, two, or three month expirations. Options with expiration dates exceeding three months will generally not be considered.
(5) Any and all strike prices with the potential to generate the minimum returns identified above will be considered. Equity price volatility, trend, and overall market direction will be taken into consideration when determining whether to write ITM, ATM, or OOM CC positions.
Managing Positions:
(1) Generally speaking, Troy will employ a “buy and hold” strategy on his open positions. He will not attempt to maximize his return by trading in and out of a position during the month.
(2) CC positions with ITM options on expiration day will be allowed to be called away.
(3) CC positions with OOM options which expire on expiration day will be reevaluated based on the existing position criteria identified above.
a. A new trade will be entered for those positions meeting the existing position criteria. New trades will be entered on the Monday following Friday expiration.
b. Positions not meeting the ‘open position’ criteria will be exited on the Monday following Friday expiration regardless of profit or loss.
Exiting Positions:
(1) An open position will be exited the next trading day when the closing price of the equity is less than 85% of the net cost of the position.
(2) As stated above, positions with ITM options on expiration day will be allowed to be called away.
Deep OTM NP Selection Strategy:
In general terms the Deep OTM NP Selection Strategy consists of two selection criteria, (1) the amount of down-side protection relative to the number of weeks to expiration, and (2) the Put Factor (PF) of the naked put being considered.
Biotech stocks as well as small and mid-cap stocks headquartered in China will be automatically eliminated from consideration due to their extreme volatility.
Entering Positions:
(1) NP trades will be selected after the market close each Friday. These trades will be executed at the open on the following Monday (or the next trading day).
(2) NP trades will only be entered on options having a PF >= 2.0
(3) NP trades will have a minimum amount of downside protection (DSP) dependent upon the number of weeks to expiration (see below matrix)
- 5 Weeks to Expiration — > 20% DSP
- 4 Weeks to Expiration — > 17.5% DSP
- 3 Weeks to Expiration — > 15% DSP
- 2 Weeks to Expiration — > 12.5% DSP
- 1 Week to Expiration — > 10% DSP
(4) The amount of capital allocated to any one Deep OTM NP Strategy trade will be based on the following matrix:
- Strike Price < $10 – 10 contracts
- Strike Price > $10 and < $20 – 5 contracts
- Strike Price > $20 and < $30 – 4 contracts
- Strike Price > $30 and < $40 – 3 contracts
- Strike Price > $40 and < $50 – 2 contracts
- Strike Price > $50 – 1 contract
Managing Positions:
(1) Generally speaking, Troy will employ a “buy and hold” strategy on his open positions. He will not attempt to maximize his return by trading in and out of a position during the month.
(2) NP positions on OTM options on expiration day will be allowed to expire.
(3) No action will be taken with NP positions that are ITM on expiration day. Troy will allow the stocks to be put to him on the Monday following expiration.
Exiting Positions:
(1) Stocks “put” to The Money Tree account due to ITM NP trades will be sold at the best possible price on the Monday following assignment.
(2) ITM NPs identified using this strategy will never be rolled out to delay or eliminate the possibility of assignment.
Jeff said
Nice job! I especially like the extensive criteria list.
The things I had questions about when I was reading through it was as follows:
1. Since NP and CC are synthetically equivalent positions, if the NP is fully secured by cash, what criteria will you use to decide whether to establish a CC or NP as your initial investment?
2. Do you plan to use margin or not on your NP positions? You should state your policy in this regard as a part of your plan.
3. You give yourself the flexibility to enter ITM, ATM, or OTM for covered calls. Why are you limiting yourself to only OOM for NPs?
4. As you gain more experience and comfort with CCs, I suspect you will change your plan regarding holding your positions — you will want to develop a strategy for roll-ups and roll-downs to further enhance the returns you are achieving.
Overall, nice job! I’d strongly advise considering this as your starting point. Consider it a work-in-progress where you can modify, update, and tweak your plan whenever necessary as you refine your processes.
Best Wishes,
Jeff
mounddweller said
Jeff,
Thanks for the feedback. I appreciate you taking the time to review my trading plan. Below are my thoughts on your observations:
(1) Right now I’m only selling NPs using cash I don’t want to commit to the market. Thus, all of my NP are very far OOM trades with a very low probability of being assigned. You’re right, I could create an equivalent position by doing a deep ITM buy/write CC, but I just prefer NPs.
(2) I didn’t mention margin simply because I do all of my CC/NP trading in IRA accounts.
(3) See response in #1 above.
(4) You’re right on the money here. I’m not very comfortable rolling my positions. On one hand I can see the benefit of being patient and working with what the market gives you to enhance your returns on a position or recover from a significant decline in a trade gone bad. However, on the other hand, I think having a stop loss plan in place or having a strict exit strategy can be just as effective because you can then redeploy your capital to another more suitable opportunity.
Again, thanks for your comments. I greatly appreciate them.
Troy
Jeff said
Very good, Troy.
I know we differ slightly in our strategies, as you pointed out under Managing Positions #1. I prefer current month with the intent to be called out. Of course, it doesn’t always work that way so I may end up holding for a few months more.
I was wondering, have you every truly employed Exiting Positions #1?
Jeff W
mounddweller said
Jeff,
It looks like I need to rephrase #1 under Managing Positions. Like you, my objective is to be called away every month at expiration. What I’m trying to communicate in #1 is that I don’t plan on trading in/out of a position during the month. For example, I know people who after selling a call for $1.00 will buy it back if it drops to $0.25 within the first two weeks of the option period. They’ll then resell the option again if it goes back up to $0.35 or more. I don’t care to do that. I find an option that meets my criteria, sell it, and then hold on until expiration.
Regarding #1 under Exiting Positions. No, this is something new I want to try. My reasoning is that if my objective is to be called away at the end of the month and my stock selection criteria (as documented in my trading plan) supports this objective, then if the stock doesn’t perform as anticipated I must admit a mistake has been made and exit the position ASAP to minimize the impact of that mistake. Then, I can redeploy the remaining capital in a new position that meets my selection criteria. Obviously, if I end up having to exit a significant number of positions this way, I’ll need to reevaluate my selection criteria because it isn’t working as intended.
The reason I want to try this is because I have many postions that I’ve entered over the last year or two that are now down 30 – 60% or more. For example, earlier this year I entered a postion in GE around $30. The stock, as you know, is now around $10. It will take many, many, months, if not years, to get back to even. In hindsight, it seems to me it would have been better to cut my losses at around my 85% of my net cost (say approx. $25) and then enter a new position that met my criteria.
Now, if your objectives were different (say you want to sell CCs on a portfolio of long-term holdings) then this approach might not make sense.
Thanks for reading my blog and sharing your thoughts, I appreciate it!
Regards,
Troy
Jeff said
Troy –
Regarding GE, as an example, I had 3-4 like this that I dumped for, in some cases, a huge loss late last year. I figured that the money can be put to better use and my portfolio recover faster that way. I estimated that I could recover, maybe, 1% or so a month, and if the stock recovers, I would be rolling ITM calls every month. Not part of my plan. Not when I can do 3-5% starting over.
Sure it makes the numbers look bad when you take a realized loss, but there are times when you have to use some tough love.
Keep checking my blog – some new and exciting features coming soon! Also comments are welcome – it help your ranking in Google. Have a great weekend.
Jeff W
Russ said
Troy, I’m new to the MT Trading plan. I’m a DFW ( Garland ) resident doing the Snider CC strategy for the last couple years. I’ve grown disgruntled with Snider’s stock selection method and therefore searching for other selections. I ran across Groenke’s book on the CC chat board and read it today which brought me to your web site. I’m encouraged by your results and impressed with the thoroughness of your blog…thanks for doing this.
My question is how position size determined ? Does PIE or another of Groenke’s tools tell you how much to invest in a particular position? Thanks for the advice.
Russ
mounddweller said
Russ,
Thanks for the positive feedback on my blog. I appreciate it. I very much enjoy writing my blog as it allows me to record my thoughts and the results of my trades. You mentioned a CC chat board. I presume you were refering to ‘justcoveredcalls’ on Yahoo. That is an excellent site for learning everything there is to know about covered calls and to a lesser extent, naked puts.
Now, regarding position sizing. No, PIE isn’t designed to tell you how big a position you should take on any one particular trade. I don’t have any hard and fast rules that I follow either. However, I do have a few guidelines that I try to keep in mind when I’m thinking about how big a trade I want to initially enter.
(1) I consider the overall riskiness of the stock. I’m more willing to enter larger positions with well known, large cap companies that I know something about than I am with mid-caps stocks.
(2) I also consider the overall condition of the market. Is it behaving badly? If so, I’ll be more cautious and reduce the size of my trade.
(3) I also try to build in some cushion. For example, if the total amount I’m willing to place at risk in a trade is $10,000, I might limit my initial position to $5000 or $6000. Then, if the trade moves significantly against me I can buy more to average down without ending up with too much in one stock.
(4) Finally, I also look at how many other open positions I have and the size of my cash reserves. If I have a lot of open positions I’ll reduce the size of any subsequent new trades so I can maintain a certain level of cash reserves.
Hope this helps.
Regards,
Troy
Russ said
Troy, a couple more questions if you please. I’m the type of person that needs an expert to answer questions once and a while. Does Groneke have a customer service line available for Q&A?
Do you recommend Groneke’s 2 day class as a pre-requisite to doing this method ?
I thought I saw you reside in the DFW area – which city ?
Thanks, Russ
mounddweller said
Russ,
No problem! Yes, Ron is very accessible. However, he doesn’t have a customer service telephone number. Rather, he does everything via email. I have found him to be very responsive whenever I have a software issue. I once had a software issue at 6:30 on a Friday evening. We exchanged emails until after 10:00 pm and my problem was fixed. He is also very open to responding to questions regarding his methodology and approach. With those types of questions he may be a little slower (a day or two) in getting back to you depending on what else he has on his plate.
I highly recommend Ron’s 2-day seminar. The class size is small. As I recall there were only about 12 people in the seminar I attended. Thus, you have ample opportunity to ask Ron questions before, during, and after the sessions. That being said, I don’t think you absolutely must attend his seminar before using the software. The seminar helps reinforce the concepts presented in his book and gives you an opportunity to walk-through the functionality of the software “live and in-person” with its creator. Before attending the seminar I pretty much limited my use of VISIONS to the SCOUT Express functionality. After attending the seminar I was able to better comprehend the power and value of all of the other functionality included in VISIONS.
By the way, I live in Flower Mound.
Regards,
Troy
Russ said
I just thought of my other question. Are their any specific rules you use to determine whether to purchase a CC ITM vs OTM ? I see examples in Ron’s book both ways. It isn’t clear when he’s choosing which. My conclusion is as long as that particular option meets the magic table criteria he’s happy because if it OTM he knows he’ll still make money.
mounddweller said
Russ,
Here are Ron’s thoughts on that subject. This information comes from the presentation materials he distributed at the 2-day seminar.
In-The-Money (ITM) – Sell ITM covered calls if there is concern that the stock may go down. This is also a good strategy for short-term gains that beat money market or CD rates.
At-The-Money (ATM) – Sell ATM covered calls if it appears that the stock (or market) is going nowhere.
Out-Of-The-Money (OTM) – Sell OTM covered calls when a stock is in a good up trend and the overall market is rising.
I agree with Ron’s approach, however I would add that I, when opening a new position, will almost always sell an ATM call. If the market is in a strong up trend then I’ll look harder at the OTM calls. If the overall market is falling I’m more likely to ask the question do I want to do this trade at all.
Regards,
Troy
Russ said
Troy, thanks for this….it’s very helpful. BTW, I signed up for Ron’s 21 day free trial today. Next question….do you or Ron have any exit rules for a CC position when it moves against you? Your previous note mentioned you’ll enter a partial position and bought more to average down. At what point do you exit the position entirely? IDB ( Investor Busines Daily) rule is get out when the position moves more than 7% – 10% against you. Snider’s method is continue to buy 100 share positions regardless if the stock to fall until you’ve accumulated 10-100 share positions and then wait and sell only when the stock rises back to the average cost. As you can imagine I haven’t had good luck with this approach in the last 24 mos….thanks for the advice.
mounddweller said
Russ,
Glad to hear you signed up for the 21-day trial. I suspect Ron is too;-). You asked about exit rules. I’ve never communicated with Ron on this topic so I can’t tell you definitively if he has any exit rules and, if so, what they are. However, by reviewing his trading history I can tell you it appears he doesn’t like to give up on a position and take a loss. He almost always stays in the trade and tries to work it until he has a positive return. Now that you’ve signed up for the 21-day trial you too can review his trading history by clicking on the Score Cards button located on the VISIONS Stock Market Explorer Home Page. The Score Cards contain all of his trades up through the end of the prior month.
I do not have any hard and fast exit rules. Most often I will hold onto a position and wait for it to recover or try to work myself back into positive return territory by either selling naked puts, buying additional stock to lower my average cost, or selling covered calls below my break-even point (if they’re ITM at expiration I’ll either buy them back or roll them out). It has been my experience that once I give up and close the position invariably the stock turns around and makes me regret my decision. Bottom line…I think you have to be patient (something I’m trying to get better at). I currently have 4 or 5 positions that I’ve been holding for over a year waiting for them to turn-around. These are all ‘left-overs’ from before I started following Ron’s approach and using VISIONS.
Regards,
Troy
Larry Barnes said
Troy- been trying to learn CC since March 09, and have become very interested in Groeneke’s Visions program. I have had Visions for about 60 days and have signed up for the November 2-day seminar(sounds like it may almost be a full class this time). Thanks, also, for your comments about Visions.
Your blog and trading plan are very helpful and I really appreciate the time that you have spent sharing them. I also appreciate yourthoughtful inputs in the JustCoveredCalls blog.
I continue to wrestle with developing an effective exit strategy but I supposed evryone must develop something with which they are confortable, etc.
Anyway, thanks again from a fellow Texan (Ft. Worth, Lubbock, College Station)for all the information you have shared. I look forward to trying to become more competent with Visions.
Regards,
Larry B
mounddweller said
Larry,
Thanks for the positive feedback. I truly enjoy writing my blog. I get alot of satisfaction knowing that others find it of value.
Regarding exit strategies, I have come to realize that this is the most important aspect of an effective trading plan. In reviewing my results in years past I found that my overall success or failure came down to one or two losing trades. In most cases if I had simply exited my position once it turned against me my overall results would have been vastly improved. This is hard to do. Human nature being what it is, you just naturally want to hang on believing it will turn-around. You don’t want to admit you were wrong about the trade.
Unfortunately, I still haven’t settled on a hard and fast rule on exactly when to take the loss and exit the trade. My trade plans says 85% of net cost (i.e., down 15% from entry point). Should it be higher or lower, who knows? I think part of it has to be a judgement call. What’s the market doing? How’s that sector of the market doing?
Let me know what you decide.
Regards,
Troy
Jeff said
Troy,
I have been the victim recently of a couple of bad trades. I have also been challenged by some of the readers of my blog as to why I don’t have an exit plan when a trade goes wrong. I am in the process of forming a strategy for exits, but it’s hard to test in a market like we are having right now.
I even made a short video related to setting exit points related to support trend lines. I have had two test trades break this support line and I immediately exited. Now, 3-6 days latter it turns out to have been a good move.
I will be refining and documenting this strategy and adding it to my trading plan in the very near future.
Also, my latest post addresses ways to accept losing trades and our tendency as humans to not ‘believe’ the market would do that to us.
Jeff W
http://buywrite.wordpress.com
Rich said
Larry, I have to agree with Troy, its hard to come up with a sure fire rule. One thing you can do is only do a buy write on a stock when its in the Visions V and the program gives you a time to act signal and then if the stock falls out of the V to the bottom you can buy back the call and exit the stock. You can also try to figure out the stocks support level and monitor for that. If it goes below you can bail out. It has to be something you are comfortable with.
Rich
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